The stimulative effects of intergovernmental grants and the marginal cost of public funds

Author
Dahlby, Bev
Ferede, Ergete
Faculty Advisor
Date
2016
Keywords
intergovernmental grants , marginal cost of public funds , flypaper effect , fiscal federalism
Abstract (summary)
This paper tests the hypothesis that the stimulative effects of intergovernmental grants increase with the marginal cost of public funds of the recipient government. We present a simple theoretical framework that shows how a lump-sum transfer stimulates the marginal expenditures of a recipient government through an income effect and a price effect. We then test the prediction of this model using Canadian provincial data and exploit the discontinuity in the equalization grants allocation formula to identify the effects of grants. Our results indicate that the stimulative effects of lump-sum grants on spending increase with the provincial government's marginal cost of public funds (MCF). One policy implication of our results is that higher intergovernmental transfers may be welfare improving if the federal government has a lower MCF than the provinces.
Publication Information
Dahlby, B. and Ferede, E. (2016). “The Stimulative Effects of Intergovernmental Grants and the Marginal Cost of Public Funds.” International Tax and Public Finance, 23(1):114-139.
Notes
Item Type
Article
Language
English
Rights
All Rights Reserved